Being able to access cash without having to sell your home or make repayments can be life changing for many retirees. If you’re considering a reverse mortgage, though, it is important to understand how interest is charged on the loan and how it will impact your home equity over time.
How is interest charged on a reverse mortgage?
Interest is calculated daily on the outstanding loan balance and is added to the loan monthly, meaning the interest compounds, or grows, over time. The amount of interest you’re charged will vary significantly depending on how much you draw down, so it makes sense to structure the loan in a way that suits your situation and means you only borrow what you need. Here’s what some potential drawdown options might look like.
– A lump sum drawdown or initial advance can be used for one-off big-ticket expenses such as repaying debt, making home improvements, upgrading a motor vehicle or travel.
– A monthly advance provides a regular payment to complement other income and take the stress out of day-to-day living expenses.
– A cash reserve facility provides a ‘line of credit’ for future needs or unforeseen circumstances. Interest is not charged on funds unless they are accessed.
– …or a combination of any of the above.
How does a reverse mortgage impact equity?
Steve and Sheryl, both 70 years old, live in a house worth $750,000. They take out a reverse mortgage in order to pay off the small remainder of their original mortgage as well as some credit card debt, plus make some improvements to their home.
Steve and Sheryl apply for a loan of $100,000 – the amount they’re eligible to borrow is calculated using their age and the value of their home. They choose to draw down an initial lump sum of $50,000, which gives them the funds they need to pay off their debt, cover the renovation and visit the grandkids.
When Steve decides to sell his car a year later, they repay $10,000 off the loan, which reduces the interest they’ll be charged and provides them the freedom to redraw the money in the future. Six months later, they redraw this $10,000 in order to pay for a holiday, followed by $15,000 for a medical procedure for Sheryl a year later.
Let’s say Steve and Sheryl’s house increases in value by 3.00% per year and that the interest rate on the reverse mortgage is 7.00% p.a. After 10 years, the loan has grown from $50,000 to around $125,000 – however, the value of Steve and Sheryl’s home also increases, meaning they actually end up with more net equity (in future dollars) than they did before they took out the loan.
This is only one example, and the outcome will vary case by case depending on how much is borrowed, how long the reverse mortgage is in place, the property growth rate and the interest rate changes over time. Inflation over time will also impact the value of this equity in the future.
To see a visual representation of this scenario, watch the explainer video below.
Heartland is New Zealand’s leading provider of reverse mortgages and has helped nearly 20,000 customers live a more comfortable retirement. To see how a reverse mortgage might impact your home equity, use the loan projection calculator on the Heartland website, or contact their friendly team on 0800 488 740 or reverseinfo@heartland.co.nz to enquire today.
Applications are subject to loan approval criteria. Heartland Bank Limited’s responsible lending criteria, terms, conditions, fees and charges apply.